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Netflix Makes Itself Vulnerable

In a daring move, the movie renter finally tweaks its pricing plans.

The DVD rental specialist is introducing a "streaming only" plan in the United States today. More importantly, it's also coming through with its first price hike in years.

Everyone probably saw this coming, but this morning's news is sending shares of the flick flinger to a new all-time high, as investors begin to reassess the value of Netflix's growing base of 16.9 million subscribers.

Now, couch potatoes can pay $7.99 a month for a plan free of Netflix's signature red DVD mailers. As long as someone is satisfied with the tech darling's woefully incomplete but rapidly growing digital library, the new plan offers unlimited streaming through a growing assortment of Internet-connected devices.

The entry-level unlimited streaming and DVD plan, which allows users to rent a single disc at a time, will go from $8.99 to $9.99 a month. The $13.99 monthly plan for two discs out at the same time will get a similar buck bump.

In a gutsy move, the flagship $16.99 plan that offers three DVDs out simultaneously is going up by nearly 18% to $19.99 a month. The larger plans are going up even more.

Many existing Netflix subscribers will cringe at the new prices, but shareholders are understandably elated by the news.

There will be some pitfalls to watch out for, though, and I'll get to them after thanking Canada and Coinstar(Nasdaq: CSTR) for giving Netflix the flexibility -- or is that Netflixibility -- to go through with these bar-raising initiatives.

The Perfect StormThere are certainly plenty of events that are giving Netflix the golden opportunity it's seizing today. The collapse of Movie Gallery -- and near collapse of Blockbuster -- are helping along with the bewildering lapses by typically astute Apple(Nasdaq: AAPL) and Amazon.com(Nasdaq: AMZN) to let an old school company with a chunky chain of bricks-and-mortar regional distribution centers beat it to the only digital celluloid model that's working.

When Netflix launched in Canada with a $7.99 price point for a disc-less service two months ago, it was a trial balloon for the rest of the world. Would Canadians sign up for the plan in droves? Would they resent the $8.99 plan that also includes DVD delivery to their southerly neighbors?

We don't have any hard metrics in Canada, short of Netflix proclaiming it a success. However, it would have been a real slap in the face to Canadians if Netflix would have launched at a lower price point in the United States for a stream-centric offering. Once CEO Red Hastings revealed in September that his company would be rolling out a similar service for stateside users, the $7.99 price point was practically a lock.

We also can't forget the shiny Redbox kiosks. For months, Coinstar had been promising to peel back the curtain on a streaming service come October.

The hyped announcement was lame. Redbox wasn't going to roll out a service with the same cutthroat pricing that made it the lone thriving local DVD renter it is today. Instead, Coinstar would team up with a third party -- rumored to be either Amazon or Wal-Mart(NYSE: WMT) -- for a Redbox-branded service, eventually.

That was it. Redbox's inability to launch a digital platform at a low price point with a deep library gave Netflix all elbow room it needed to go through with today's rate hike.

The Blind SideAs a longtime Netflix shareholder, I'm loving today's move. Unfortunately, I'm also concerned. There are two things that can eat into the euphoria: the trade down and the non-streamer revolt.

Let's talk about trading down. Average revenue per subscriber has been trending lower in recent quarters. In its latest quarter, for example, revenue inched 31% higher even though its account base was 52% larger than it was a year earlier.

Are new users simply gravitating to the entry-level $8.99 plan (that is now going up to $9.99)? That's clearly happening, but it's also likely that many of those on larger plans are trading down to cheaper ones now that they have on-demand access to 20,000 digital titles.

Isn't the same thing going to happen again? I wouldn't be surprised if I find myself going from the unlimited plan with three discs out at a time to the two-disc option, and pay $2 less a month than I'm paying now, even with the price hike.

The other pothole to watch out for is the resentment that may build from Netflix subscribers who don't stream. More than two-thirds of the company's customers stream at least a little, but what about the other 34%?

They had no reason to complain when streaming was added, because it came at no additional cost. Now that Netflix is going through with its first rate hike since 2004, the "stream nots" may not be as happy as they used to be in subsidizing the streamers.

"Creating the best user experience that we can around watching instantly is how we're spending the vast majority of our time and resources," Netflix explains in this morning's announcement. "Because of this, we are not creating any plans that are focused solely on DVDs by mail."

In other words, get on the bandwidth bandwagon, stream-nots -- or suck up the subsidization.

The Constant GardenerNetflix will have to be careful at this point. Couch potatoes hardly relish a price hike.

Sure, cable television bills and movie ticket prices go up every year, so why not Netflix? However, Netflix is making this move as its streaming service comes increasingly under fire. It recently added another content delivery network -- Level 3(Nasdaq: LVLT) -- after a few outages. Cable giant Comcast(Nasdaq: CMCSA) is also promoting its Xfinity digital offering as having 20,000 titles available on demand.

Today's applause will be worth it if Netflix is able to keep churn in check and its subscriber base growing next year. That won't be easy, but Hastings wouldn't have it any other way.

Longtime Fool contributor Rick Munarriz has been a Netflix shareholder -- and subscriber -- since 2002. Rick is also part of theRule Breakersnewsletter research team, seeking out tomorrow's ultimate growth stocks a day early. The Fool has adisclosure policy.

Author

Rick has been writing for Motley Fool since 1995 where he's a Consumer and Tech Stocks Specialist. Yes, that's a long time with more than 20,000 bylines over those 22 years. He's been an analyst for Motley Fool Rule Breakers and a portfolio lead analyst for Motley Fool Supernova since each newsletter service's inception. He earned his BBA and MBA from the University of Miami, and he splits his time living in Miami, Florida and Celebration, Florida.
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